This document discusses active value investing in range-bound markets. It provides analysis of different types of market cycles including bull, bear, and sideways markets. Key points made include that secular markets can be bullish, bearish, or range-bound depending on starting valuations. Sideways markets occur when valuations start high and end lower, resulting in low or no returns from price appreciation alone. The document emphasizes the importance of stock selection and valuation in range-bound markets over strategies like buy and hold. It offers recommendations for investing in the current environment, such as favoring dividend stocks and looking overseas.

1. Vitaliy N. Katsenelson, CFA
Chief Investment Officer
Investment Management Associates, Inc.
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4. Active Value Investing Net of Fees performance is after
the deduction of management fees, after reinvestment
of dividends, interest and other earnings (recorded on
accrual basis), and after the deduction of broker fees
and commissions.
S&P 500 market average includes reinvestment of
dividends but are not adjusted for any transaction
costs.
Past performance is not necessarily indicative of
future results and is only one of several factors which
should be used in evaluating a professional
investment organization.
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5. We are used to thinking about secular (longer than 5 years) markets in
binary terms:
OR
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6. There is another type of long-term market – Cowardly Lion or Sideways
“bursts of occasional bravery lead to stock appreciation, but are
ultimately overrun by fear that leads to a subsequent descent”
– Active Value Investing: Making Money in Range-Bound Markets 6

7. Dow Jones Industrial Average 100+ Years
The “bear” markets were actually sideways markets
and happened ½ the time
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8. Dow Jones Industrial Average 2000 - 2010
So far markets have gone sideways … hell of a ride, but still sideways
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9. Secular Bull and Sideways Market Cycles Were Not Caused by:
 Economy
 Earnings growth
 Interest rates
 Inflation
They Were Caused by:
 Valuation
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10. As Long As: Inflation Remained Reasonable / Deflation Was Absent / GDP And
Earnings Growth Remained Positive – Market Was Either Bull Or Sideways.
Note: Real GDP growth was extremely stable throughout all secular markets
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11. Stock Market Math
Earnings Growth
∆ Price +
+ ∆ P/E
Dividends
=
Total Return from Stock(s)
OR
Earnings Growth
+
∆ P/E
+
Dividends
=
Total Return from Stock(s) 11

12. Sources of Return
Practical Example:
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13. Wal-Mart -- A Typical Sideways Market Stock…
2001 - 2010
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14. Sources of Return: Secular Sideways and Bear Markets (S&P 500)
SIDEWAYS MARKETS
Sideways Markets: P/E Contraction + Earnings Growth = Low Returns
Bear Markets: P/E Contraction + Earnings Decline = Negative Returns 14

15. “By the Book” Bear Market – Japan
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16. Sources of Return: Secular Bull Markets
Bull Markets: P/E Expansion + Earnings Growth = Super Returns
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19. Bull Markets Start at Below-Average and End At Above-Average Valuations.
Range-Bound Markets Start at Above-Average and End at Below-Average Valuations.
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20. Bull, Bear and Sideways Markets Happen
When…
Market Economic Growth Starting Valuation (P/E)
Bull Good (Average) Low
Range-Bound Good (Average) High
Bear Bad High
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21. In a “perfect” world where humans have no emotions
stock market appreciation = economic growth = earnings growth = 5-6%
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22. The Effects of Psychology on Market Cycles
End of Bull Market
“New” average
expectations are NOT
met – P/E stopped
expanding
P/E + EPS = Sideways Market
0% + 6% ≈ 6%
Returns are NOT “new”
average, not average, but
below average:
P/E + EPS = -6% + 6% ≈ 0%
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23. Interest rates and inflation are very important but they take a second seat to market
psychology. They ultimately determine the length and the extremes of market cycles.
Good/Bad for
Interest Rates Move from Reason
P/Es
Move to
Zone 1 Zone 2 GOOD
normalcy
Zone 2 Zone 3 BAD Risk of inflation
1982 Move to
Zone 3 Zone 2 GOOD
normalcy
If interest rates /inflation
were higher, secular Zone 2 Zone 1 BAD Risk of deflation
range-bound may have
ended sooner at higher
valuation
2000
If interest rates /inflation
were not that low, secular
bull may have ended
sooner at lower valuation
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24. Still in the Sideways Market?
 Valuations are still high (above average).
 Valuations need to stay below average for a while (see next slide).
 Real earnings growth will be lower in the future due to higher future
taxes, higher interest rates (caused by government borrowing), consumer
deleveraging – sideways market may last longer than we expect.
 High inflation will shorten sideways market duration, but final P/E
will be lower as well.
 If nominal earnings growth doesn’t materialize in the future (3,5,10
years), earnings decline – we are set for a secular bear market
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26. Brief Summary of Strategy and Analysis for Today’s Environment
 Be a buy and sell investor. Buy and hold is in a coma (see next chart) . Time
(price) stocks through a strict buy and sell process. Buy when undervalued, sell
when fairly valued.
 Time stocks, not the market: Market timing is very difficult. In the short run
emotions are in the driver’s seat.
 Don’t buy for the sake of being invested. Don’t lose money by making marginal
decisions. In the absence of good stocks to buy, be in cash. The opportunity cost
of cash is not as high as in a secular bull market.
 Increase your margin of safety: Fewer (better) stocks will be in your portfolio.
 Favor dividend-paying stocks. Dividends were 95% of the return in previous
range-bound markets. (Warning: dividends are part of the analytical equation, not
the equation.)
 Look overseas -- increases return without increasing risk.
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27. Bull Markets: Stocks Do Outperform Bonds Hands Down
Throw money at stocks, and you’ll do much better than in bonds or cash. In general, the fewer
decisions you make the better off you are (buy and forget).
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28. Sideways Markets: Stocks’ Dominance Is Not Significant
Asset allocation is not as important as stock selection.
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29. Conclusion: Stock Selection Matters A Lot!
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30. Thank You!
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7979 E. Tufts Ave, Suit 820, Denver, Co 80237
303.796.8333 / www.imausa.com
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31. Secular Range-Bound Market Is Comprised of Many Cyclical Markets
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